Macro Research

Market Valuations

Many are familiar with market valuation indicators such as trailing, median P/E ratio, P/B and dividend/price ratio. In this article, I am not explaining the use of such indicators but wanted to introduce one that is relatively not known to many these days. Personally, I only found out about it recently, given my preference of using the long favored market valuation ratio, one even Warren Buffett pointed out to be ‘probably the best single measure of where valuations stand at any given moment.’ That would be the ratio of Total Market Capitalization to US GDP (TMC/GDP), which would stand at approximately 1.241 as of today, indicating that markets are significantly overvalued.

Everyone would be familiar with the term ‘Net-Net’ coined by the great Benjamin Graham, which just means to a company being priced below the value of its current assets less all liabilities. While we understand the implications of a company being a net-net, what are the implications when used on a market level?

Based on research done, just from the number of net-net companies compared to the S&P 500 Return, we are able to have a feel of the valuation of the market.

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From the research conducted by Graham Theodore & Co. Ltd., we are able to observe the inverse relation between the number of net-nets in the market and the S&P 500 Return. The greater the number of net-nets, it would indicate a more bearish market, with market valuations on the low side and vice versa. With that said, looking at the current market today (NYSE MKT LLC, NYSE, NASDAQ) there are only a total of 59 net-net companies and the average annualized returns from 2012 to present would be approximately 21%. Compared to the initially mentioned TMC/GDP ratio, it would indicate that market valuations are indeed overvalued.

Looking at past history, the highest point TMC/GDP ever reached was 1.48 during the technology bubble in 2000. What does it mean for us going forward now? I am not saying that we should all start winding down our portfolios and sit on cash, however, it would be best that we hold a larger proportion of our portfolios in cash and consider realizing profits for companies nearing their fair value.

China Residential Market

From the latest results from the National Bureau of Statistics of China, we can observe that in terms of supply of real estate, the Central Government’s policy is working. China’s real estate sector slowed in May where investments in real estate rose 14.7% during the first five months of 2014, slowing from the overall rate of 16.4% recorded during the period from January to April 2014. Furthermore, we see new construction starts decreasing 18.6% during the period of January to May compared to that of last year.

However, if one were to look deeper, the government’s policy may not be working that well. Looking at demand, we see home sales for May alone to be down 11% compared to that of last year. This translates to an 8.5% slowdown in property sales from the period of January to May 2014, compared to that of last year. Furthermore, Soufun reported earlier this month that 62% of China’s cities recording falling home prices for the month of May. A survey by China Index Academy, a unit of Soufun.com, saw average home prices dropping 0.3% in May compared to April. Furthermore, it was previously reported that only home prices in smaller towns in China saw home prices falling. However, we see home prices in first tier cities, where homes in Shanghai Commercial Centre saw prices fall by 0.4% compared to last month. Among China’s 10 largest cities, Nanjing saw the biggest drop in May of approximately 1.4% and only 2 cities recorded increases in home prices – Bejing and Tianjin.

While we see the slowdown in supply of real estate, this is partly attributable to problems developers are facing. Developers are facing the problem of tighter cash flows, where housing brokers complain about unpaid commissions.


A third of all developers that we are helping sell projects have not paid us commission fees according to the payment schedule

Director of Hopefluent Group Holdings, Fu Wai-Chung commented. The firm operates 280 branches across the Mainland, and was marketing about 600-700 property projects.


Developers are deferring their payment from 90 to 120 days as credit tightening and a decline in property sales hurt their cash flow

Furthermore, Head of Residential Sector at DTZ Greater China, Alan Chiang Sheung-Lai agreed that their company was in the same boat.


Small developers are not only the ones that owe us money, but also major players

Chairman of Centaline China’s parent Centaline Group, said. Developers owed the firm RMB1bn in unpaid commissions for this year, lifting its accounts receivable to RMB2bn. Furthermore, one such developer, Huizhou-based Guang Group had paid Centaline commissions in the form of several flats, and they had sell them at below-market prices.

Despite it all, an official from China’s think tank said that the current real estate market correction is under control and that the country’s economy is strong enough to manage its impact.


Based on our research, risks for the property market still controllable

Vice President of the China Academy of Social Sciences, Li Yang commented. Furthermore, given how the value of properties held by individuals is still much higher than their mortgage obligations, this limits the risk of panic selling.

I attended a happy hour for professionals within the real estate industry yesterday night. The surprising thing was that I actually met other professionals from other sectors such as someone from uber, the hospitality sector etc, which was really interesting. One could actually see how interconnected industries are, where I even saw someone from the carpet industry attending this social event to network with property developers. Anyway all that aside, after talking to the industry’s professionals, it is their view that it is unlikely that China would enter into a recession, where the property bubble will not have repercussions as bad as that of USA. Furthermore, the Chinese government has more fiscal might to bail companies out in the event of such a scenario. That said, I won’t be better against this from happening.

China – A Second Bubble?

Believe many readers have noticed that my previous 2 blog posts aren’t posted by me. My best friend I mentioned whom I started my investing journey with, is currently an author of this blog too.

Anyway, been researching into the China property market, with a main focus in the residential market. Sorry for the lengthy post (heh!) I tried my best to be concise.

Recently, Yu Liang, CEO of China Vanke – the largest residential real estate developer in the People’s Republic of China predicts that majority of the China’s property developers will cease to exist within the next 15 years. Yu’s remark is not the first time developers have sounded a bearish note on the industry. Pan Shiyi, Chairman of Soho China and Ronnie Chan, Chairman of Hang Lung Properties are some of the others having a pessimistic view on the China Residential Property industry. In this research, I would be delving on why developers have taken such a negative stance despite China’s GDP growth still in the 7% region.

Looking at the current residential property industry in China, it would reflect a property bubble, one similar to that in the USA before the lead up to the Global Financial Crisis in 2007. With the cheap money supply in China, developers borrowed heavily from shadow channels, using property as collateral for large proportion of their loans. Given the soaring housing prices within China, one would expect it to be attributable to demand outstripping supply. On the contrary, it is the exact opposite. We see many ‘Ghost Developments’ in big cities like Shanghai and Beijing. In recent studies, Beijing alone has 3.8million vacant homes as compared to the 1million vacant homes in the USA during the same period. Furthermore, in a mid-sized Hebei province city, home ownership rates are at 200%.

Despite all this vacant homes, property prices are still trending upwards due to government policies. The Chinese government restricts her citizens in investing in anything outside China, and given how Chinese stocks are notoriously volatile; the most popular store of value is residential property.

First tier city housing prices at sky-high prices by annual measures due to buyers from all over China keeping up demand, assuming that it is the safest bet. However, these markets bear little resemblance to China’s smaller cities, where collapsing prices are rampant. New home prices have fallen in 8 out of the 70 cities (e.g. Wenzhou, Ningbo) in the recent month compared to the previous month where only 4 reported falling prices. Furthermore, cities like Tangshan, Hangzhou, and Haikou that are threatening to tip into negative growth. With home prices to have risen 9.5% in 2013, Bank of America Merrill Lynch expects the pace to moderate to just 5% in 2014.

Such slowdown in prices is due to the Chinese demographics and government policies in curbing a property bubble. With the rapid aging population of the Chinese population, it would mean that future workers will have less to spend due to the decrease in disposable income to spend on housing in the next 2 decades. Furthermore, the government has implemented policies such as a 70% down payment on house purchases and a 20% capital gains tax on sale of second homes to reduce demand in big cities. With such downward trend in prices and decrease in sales where only 28% of China’s domestically listed property companies reporting net cash inflow for 1Q2014 as reported by Goldman Sachs Gao Hua, it would result in a vicious cycle. Even major developers like China Vanke have reported a first quarterly drop in profits since 2002 or Soho China’s profits for 2H203 down 47% vis-à-vis 2H2012.

Given how down payments and mortgages generating about 40% of developer’s investment capital, slowing sales would mean developers needing cash so desperately that they will keep slashing prices. Furthermore, this is exacerbated by the developers having to repay their loans to the banks. This is evident by the fact that major developers have slashed prices by 15% since March, as reported by Bloomberg. On the demand side, with widespread knowledge of property developers’ shaky financials, buyers would be skeptical investing in unfinished developments in fear of developers going bankrupt. With the slash in prices, it would scare off speculative buyers, which makes up 15% of the demand for new homes, causing demand to fall even further.

With residential property being a lynchpin of China’s economic growth, collapse in house prices will drag a huge part of China’s GDP down. Coupled with other factors such as lackluster demand for exports and the government’s push to cut its own investment in bid for reshaping the economy, it has resulted in the China’s GDP growth averaging 9-10% in the past decade to have fallen to 7.5% in 2013. With the property market slide and slowing economy, it has caused difficulty for developers in repaying their debts. Banks would be left with defaulting borrowers and collaterals that are now worth a fraction of what they are owned. In bid to recover some of the loans, banks would resort to a massive selling of its collaterals, causing housing prices to fall even further.

With such a trend, it is inevitable that we expect to see smaller developers either going bust or getting acquired, seeing a separation between the men and the boys. Moreover, we are beginning to see this happening where the Chairman of Greentown China sold off his controlling stake to Sunac Holdings. With this going forward, we would definitely see a consolidation in this industry, where 85,000 of the developers now would decrease to 100 major developers and 15,000 smaller developers. Of course, it would really have to depend on the government’s ability in using a loose monetary policy in resolving this issue.

In my opinion, I would start reducing my investments in any listed companies whose main business in dealing with residential property or rather any form of property in China. To be honest, if the Chinese government is unable to prevent this bubble from bursting, it would be another global recession again. In such times, perhaps it would be best that a larger proportion of our portfolios are in cash.